Stocks

Understanding Stocks

Stocks represent ownership in a company. An individual who owns stock is also known as a shareholder or stockholder.  An individual who buys stock is hoping to participate in the future profits of a company in order to generate wealth through investing. While shareholders are considered part owners of a company, stocks do not guarantee a return of your investment and are last in line in the event of bankruptcy, making them riskier than bonds.

In order for you to make money as a shareholder, the company that you bought stock in must first meet all of its other financial obligations and have earnings high enough to remain competitive and grow. When a company is making money, they can decide to pay shareholders some of the earnings in the form of dividends.

Dividends are a distribution of profits made by a company to its shareholders. Companies will publicly announce their ability to pay a dividend and require shareholders to own company stock, based on a specific date in order to receive a dividend. This specific date is known as the record date. In order to receive a dividend, shareholders must be the holder of shares on or before the record date.

There are two types of stocks:

  • Common Stock- Shareholders are entitled to dividends and have the ability to vote on company decisions through shareholder meetings, which occur at least annually.
  • Preferred Stock – Shareholders receive dividends before shareholders of common stock and also hold seniority in the event of a bankruptcy, where preferred shareholders are paid first before common stockholders. Preferred shareholders do not have the ability to vote on company decisions.

Companies who decide to create shares of their company, and issue them for purchase to the public, must by law provide updates to shareholders in the form of reports. Once an individual is recorded as a shareholder, the person will begin to receive invitations to annual meetings with fellow shareholders, which allow for companies to track who owns shares.

These shares are tracked on what’s known as a proxy statement. A proxy statement is a document that contains information the Securities and Exchange Commission (SEC) requires companies provide to their shareholders so they can make informed decisions about matters that will be brought up at an annual or special stockholder meeting. Proxy statements are issued prior to the annual meeting and include details about the annual meeting, share ownership, board structure, executive compensation and details on other issues that will be voted on at the annual meeting.

Initial Public Offerings (IPO)

If you decide to become a business owner, you must complete an application based on the guidelines provided by the state in which you live. This process not only puts your ideas and visions as a business owner onto paper to make them a reality, but also requires you to identify its owners. In the world of financial services, if a company has one owner, this owner will hold one hundred percent equity of the business.

If a business is doing well and has a desire to grow, they may need to give up some ownership in their company in exchange for additional capital, and other resources in order to get to the next level. This may include additional investors and perhaps other individuals and businesses who you may not know personally as the business owner. Given this possibility in the finance world, every business is seen as already gone through the process of “issuing” stock.

Initial Public Offerings (IPOs) is the act of a company making shares available for purchase to the general investing public. With a majority of companies either family owned, smaller in size, or growing from existing partnerships, very few corporations issue shares through an IPO.

IPOs provide corporations an opportunity to raise money in exchange for an ownership stake (share) in the company in order to expand, refinance debt, and pursue further innovations. Some of the most well-known companies are known as publicly traded companies, given the fact that they have sold shares of their company through an IPO.

A few of these companies include:

  • Apple (AAPL)
  • General Motors (GM)
  • Facebook (FB)
  • Amazon (AMZN)
  • Walmart (WMT)

The abbreviation provided next to the company in parentheses is known as a Ticker Symbol. Ticker symbols, which are also known as stock symbols, are unique to each company that is publicly traded and helps to easily identify a company among its industry peers. In addition to a ticker symbol, corporations must also ensure their accounting records accurately reflect their valuation.

 

Stock Valuation

Valuation represents the monetary attribute of a stock in order to determine the worth of each share. The most common terms that are used to describe the valuation of a company are:

  • Book Value: Generally used for accounting purposes only. The book value represents the initial capital allocated by investors (shareholders), along with any profits that have been reinvested (rolled back in) to the company.
  • Par Value: When a company decides to issue shares, it assigns what’s known as a par value. A stock’s par value provides the lowest possible share price that the issuing company believes will be the floor for their company in terms of share price. Companies cannot assign a par value of zero; therefore, lots of companies will issue stock with a par value of .01 (one cent), such as Amazon (AMZN) and Apple (AAPL). In recent decades companies have elected to opt entirely out of assigning a par value to their stock, given its lack of significance. Par and book values have no impact on what’s known as the market value of a stock.
  • Market Value: A stock’s market value, also known as market price, represents what investors are willing to pay for the shares that are available for purchase. A company’s market value helps to represent what its market capitalization is. Using their ticker symbol, corporations report their company’s share price based on market changes.
  • Market Capitalization (Market Cap): Market capitalization is the value of all the shares a company has that are publicly traded, also known as outstanding for record keeping. Market caps help to identify the size (how much money they are worth) of a company between other companies in and outside of its respective industry.

 

Stock Rating & Ranking

A company’s stock valuation allows for investors to gauge how a business is doing. Stock price changes over time provide investors with a way to measure a company’s performance across a period in time; this is known as historical value. A stock’s historical value can be measured daily, monthly, quarterly (3 months), annually (12 months), and since a stock’s inception, or first day of trading. There are two primary methods for analyzing stocks:

  • Technical Analysis: The process of analyzing a stock’s price changes over time. Technical analysis is strictly based on data regarding stock market values.
  • Fundamental Analysis: The process of analyzing a stock in more detail by looking into how the company is operated. Fundamental analysis includes reviewing financial statements, leadership changes, and operations. In conducting fundamental analysis companies are scrutinized against industry peers as well as their vulnerability to economic changes.

Analyzing a company’s stock is helpful in determining if as an investor you should allocate capital into one particular stock over another. A company’s stock price, or market value, depends on investors’ confidence and expectations that the company that issued stock will be profitable in future. An important step in evaluating the performance of a company is to determine how it’s doing compared to similar businesses that do or offer a similar product or service. The step investors take when evaluating a company’s stock performance against other companies that are also publicly traded and have issued stock within its industry is called “ranking”.

Ranking is just as it sounds, stacking up all the stocks of companies that do the same thing or something similar and evaluating the changes in their stock market value. Given that there is a lot more to a business than just their market value (stock price), investors will also look at what’s called “ratings”. Ratings provide additional information about a company that may be outside of their financial statements. This may include employee satisfaction, leadership changes, global growth, along with many other performance measures.

 

Stock Exchange

After a corporation has issued stock, these shares are sold on stock exchanges, also known as secondary markets and stock markets. Stock exchanges are markets where shares of a company’s stock are bought and sold. Investors who do not buy shares when the Initial Public Offering (IPO) is made will only be able to enter into a transaction to buy or sell shares in the secondary market. Secondary markets do not involve the corporation that initially issued stock.

Secondary markets are broken down into two primary segments: Broker Markets and Dealer Markets. In a broker market, there must be a defined buyer and seller for a trade to happen. In a dealer market, buyers and sellers execute buy/sell orders separately and independently through dealers, who act as market makers.

The broker market includes national stock exchanges and regional stock exchanges. The two national stock exchanges are : New York Stock Exchange (NYSE), and American Stock Exchange (AMEX). The five regional stock exchanges are located in the Midwest, Pacific, Philadelphia, Boston, and Cincinnati.

A dealer market is a financial market where multiple dealers post prices at which they will buy or sell a specific security or instrument. The dealer market includes Nasdaq OMX and the Over the Counter (OTC) market. Bonds and foreign exchanges trade primarily in dealer markets, while stock trading on the Nasdaq is a prime example of an equity dealer market.

The New York Stock Exchange (NYSE) is the largest stock exchange in the world. Given the global exchange of money between countries and exchanges, in 1961, stock exchanges around the world created a membership organization known as the World Federation of Exchanges (WFE). WFE includes over 250 different exchanges and financial clearing institutions around the world that serve as intermediaries in helping to execute transactions between members.

International Stocks

International stocks represent shares of a publicly traded foreign company. Since the end of the Cold War, globalization has allowed for countries to conduct transactions between societies almost seamlessly. Investors are able to buy individual international stocks in one of two ways:

  • American Depository Receipts (ADRs): American Depository Receipts, also known as ADRs, are dollar-denominated stock that represents ownership of a foreign company, based on a specific number of shares. This allows for U.S. investors to buy international (foreign) stock using U.S. dollars. By providing the opportunity to purchase shares in dollars, this reduces foreign currency exchange risk. ADRs can be bought and sold (traded) on U.S. stock exchanges.
  • Direct Foreign Investment: Direct foreign investment provides investors the ability to buy shares of a stock directly on the foreign stock exchange, priced in whatever the local currency is for the company an investor is looking to trade (buy or sell).

Many publicly traded companies will issue shares across multiple stock exchanges. In doing this, more than one class of stock may be issued. This can create differences between stock prices of the same company on different stock exchanges.

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